Retrospective treatment of prior years financial statements is required when there is a change from

A change in accounting principle is the term used when a business selects between different generally accepted accounting principles or changes the method with which a principle is applied. Changes can occur within accounting frameworks for either generally accepted accounting principles (GAAP), or international financial reporting standards (IFRS). American companies use GAAP.

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Key Takeaways
Recording and Reporting a Change in Accounting Principles
Fransiskus Johannes,Ak., CA., CPA
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What is retrospective treatment in accounting?
Why is retrospective application required for changes in accounting policy?
When an accounting change is reported under the retrospective?
What requires a restatement of prior period financial statements?

For investors, security analysts, or other users of financial statements, changes in accounting principles can be confusing to read and understand. They need adjustments in order to compare, apples to apples, the pre-change, and the post-change numbers, to be able to derive correct insights. The adjustments look very similar to error corrections, which often have negative interpretations.

Changing an accounting principle is different from changing an accounting estimate or reporting entity. Accounting principles impact the methods used, whereas an estimate refers to a specific recalculation. An example of a change in accounting principles occurs when a company changes its system of inventory valuation, perhaps moving from LIFO to FIFO.

Key Takeaways

A change in accounting principles refers to a business switching its method of compiling and reporting its financials.
Specifically, the company will either choose between a variety of generally accepted accounting principles or switch the process by which a principle is put to work.
When a change is made, it must be applied retroactively to all previous statements, as if the method had always been used, unless doing so would be impractical.
If taking on the new principle results in a substantial change in an asset or liability, the change has to be reported to the retained earnings' opening balance.

Recording and Reporting a Change in Accounting Principles

Whenever a change in principles is made by a company, the company must retrospectively apply the change to all prior reporting periods, as if the new principle had always been in place, unless it is impractical to do so. This is known as "restating." Keep in mind that these requirements only impact direct effects, not indirect effects.

If the adoption of a new accounting principle results in a material change in an asset or liability, the adjustment must be reported to the retained earnings' opening balance. Additionally, the nature of any change in accounting principles must be disclosed in the footnotes of financial statements, along with the rationale used to justify the change. The FASB issues statements about accounting changes and error corrections that detail how to reflect changes in financial reports.

Fransiskus Johannes,Ak., CA., CPA

Professional Accountant, Auditor, and Managing Partner Infinity Smart Consulting

Published Sep 14, 2015

Financial statements are prepared based on Company’s accounting policy and estimation. Every company has a different accounting policies and different estimation as well, depend on the nature of business, size of business, strategy, internal and external environment.

Accounting policies and estimation are made to make financial statements relevant and reliable for the user and economic condition on the reporting date. In applying accounting policies and estimation, Entity is required to apply consistently, so that the financial statements can be compared with previous period. Example: if in 20X1, X Company use average method for inventory valuation, then in 20X2, they should use the same inventory valuation that they used for 20X1 in preparing financial statement 20X2. Because if, X company change the accounting policies on inventory valuation (from FIFO to average), the financial statements for 20X1 and 20X2 can’t be compared.

Consistency in applying accounting policies and estimates doesn’t mean that we can’t change the policies and estimates. Accounting policies can be changed if only:

The changes are required by Mandatory Accounting Standards (Local Accounting Standards).
The changes can produce financial statements that give more reliable and relevant information on impact of transaction, event, or other circumstances.

How it is Treated?

In applying changes in accounting policies and estimates, IAS divided into two treatments, retrospective or prospective. Retrospective means Implementation new accounting policies for transaction, event, or other circumstances as if it had been implemented. In other words, retrospective will effect presentation of financial statements for previous periods. While prospective means implementation new accounting policies for transaction, event, or other circumstances after new accounting policies or estimation has been implemented.

Prospective or Retrospective Implementation?

When prospective or retrospective implementation should be applied?

Retrospective implementation should be applied if the new accounting standards or policies are required by mandatory accounting standards and the changes can produce financial statements that give more reliable and relevant information on impact of transaction, event, or other circumstances. In the example above, if X company in 20X2 changes the inventory valuation method from FIFO to average, so that new accounting policies should be applied retrospectively. Then, the financial statements of X company for 20X1 should be restated. And Errors may arise from mistakes and oversights or misinterpretation of information. Material prior- period errors are adjusted retrospectively (that is, by restating comparative figures) unless this is impracticable.

Prospective implementation should be applied if there is changes in accounting estimation.

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What is retrospective treatment in accounting?

Retrospective means Implementation new accounting policies for transaction, event, or other circumstances as if it had been implemented. In other words, retrospective will effect presentation of financial statements for previous periods.

Why is retrospective application required for changes in accounting policy?

Retrospective application means that the accounting records be adjusted as though the new accounting policy had always been in place, so that the opening equity balance of all periods presented incorporates the effects of the change.

When an accounting change is reported under the retrospective?

A retrospective change means that the change needs to be accounted for in historical periods as well as the current and future periods. For example, if the company changes accounting principles, that requires retrospective treatment.

What requires a restatement of prior period financial statements?

Restatements are necessary when it is determined that a previous statement contained a "material" inaccuracy. This can result from accounting mistakes, noncompliance with generally accepted accounting principles (GAAP), fraud, misrepresentation, or a simple clerical error.